Lesson from Satyam: Corporate governance evolves, not execution

Seven years since the mega-fraud broke out; Satyam is a cautionary tale to companies, auditors and authorities. But has India's regulatory framework really improved?

MUMBAI: Seven years ago to this day, B Ramalinga Raju, the founder of Satyam Computer Services, confessed to a Rs 7,000-crore fraud on its balance sheet, which he had hidden from the IT company's board, employees and auditors for several years. The Satyam scandal was the largest accounting fraud in the history of corporate India and dubbed India's Enron, a reference to the American energy company that collapsed due to a mammoth accounting scandal.

Satyam rocked corporate India and laid bare many alarming truths about the inadequacies of the country's corporate governance standards. The government reacted to the fraud by overhauling the regulatory framework, with the new Companies Act 2013, which fixed liabilities of auditor and independent directors, among other changes. In 2014, market regulator Sebi amended Clause 49 of listing guidelines to improve corporate governance.

Satyam today is a cautionary tale to companies, auditors and authorities, but has it really improved India's corporate governance standards? Are corporate financial disclosure rules that determine what a company must tell investors about its operations and results robust?

To be sure, companies and auditors have put in greater checks to prevent fraud.Deepak Parekh, chairman of HDFC, says there is much more vigilance now. "There are lots of checks and balances... a fraud of the magnitude of Satyam with collusion of employees, owners, external agencies, accountants is difficult," says Parekh.

Nitin Bhatt, National Leader, Risk Advisory services, EY, says there is now greater awareness and respect for the various facets of corporate risk among companies and boards. "Most organisations have digitised their business processes and strengthened internal controls to prevent and detect frauds. Boards have also started linking the compensation and incentives of top executives to how well they manage mission-critical exposures."

Indeed, board/audit committees of companies have powers of increased oversight of corporate governance. Boards must have at least one woman director.

Audit firms now have to be rotated every 10 years beginning April 2017. Auditors have come under intense scrutiny - they have to see to it that every internal financial control (IFC) prescribed under the Companies Act is followed by a company, among other things. But are these enough? Remember even before Satyam, India's financial reporting standards were robust. The rub was weak enforcement and plenty of loopholes in the system.

Despite Satyam, companies are more concerned with just ticking the boxes, according to a number of captains of industry, auditors and industry analysts whom ET interviewed for this article. India has a long way to go to match the corporate governance standards of evolved markets, they say.

Arun Duggal, chairman of ICRA and an independent director on several boards, says the boards in the US, Australia, Singapore, Hong Kong, etc have been constantly improving. "It is hard for us to think of that level of corporate governance."

The main obstacle is that most Indian companies are controlled by promoters, according to industry watchers. Independent directors are only independent on paper. Directors are picked from an "old boy's network" - they are people close to a promoter or from a familiar circle. "Relationships/connectivity between promoters and independent directors and also high remuneration levels can often undermine true independence of directors," Pranav Haldea, Managing Director, PRIME Database That is not to say companies and independent directors are ignorant of the tougher regulations created post Satyam. By defining the responsibility of the independent director, the Companies Act lays out the ramifications if the role is not taken seriously. It is also thanks to stern rules that many professionals are turning to consultancies for advice and training before taking up the role of independent directors. Many firms are even drawing up new contracts which define the exact time the director needs to spend.

The Satyam scandal also effected sweeping changes in auditing practices. In the case of Satyam, four auditors who were then working with Price Waterhouse (PW), part of PwC India, were convicted along with Raju (they are all currently out on bail).Big Four -Deloitte, PwC, EY and KPMG- and other major auditors now conduct a risk assessment before accepting an audit. Auditors are increasingly dropping companies as clients when they discover dirt. Many auditors are also using algorithms to help discover "unusual patterns" in the books. That's not all. In the Satyam scandal, auditors relied on bank statements worth Rs 3,800 crore provided by the company. It turned out be fabricated. Under the new rules, auditors are required to check the authenticity of bank statements. Raju had also disguised the pledging of Satyam shares. Today, promoters who pledge shares must disclose it to Sebi. The Companies Act has forced companies to embrace a whistleblower policy. Indian companies are roping in specialists to manage their whistle-blowing mechanisms.

IFC too has improved oversight. Under the Companies Act, an auditor is required to state whether a company has an adequate internal financial controls system in place and its operating effectiveness. Companies themselves are doing their bit. In an attempt to usher more transparency, many are reducing human interference and turning to technology. Some bring in their risk assessment teams before they make strategic decisions like acquisitions and expansion.

Mritunjay Kapur, head, risk consulting, KPMG India, says there are now several safeguards available to investors through The Companies Act, including the area of Internal Financial Control and related party transactions.

Even so, companies have not been pushed far enough to prevent fraud. True, there has been no scandal like Satyam. But the number of frauds has not dropped sharply in the seven years though many pertain to individual fraud.

"Despite the checks and balances frauds are happening, which keeps forensic audit teams busy," says Vinita Bali, former CEO of Britannia and an independent director on several boards.

Companies obey the letter of the new rules, but not the spirit. Take the whistleblowing mechanism. Firms put safeguards to ensure revelation of whistleblowers do not backfire, according to experts.

The same is true of independent directors. SIS Systems, a Gujarat based company, is accused of a fraud worth Rs 2,000 crore. The promoter was arrested but no independent director faces charges.

Shareholder activism that could prevent fraud is lacklustre, according to Bali. "We are not yet seeing activism of shareholders as the US and Western Europe who continue to drive for greater transparency and governance, and how actions of the chairman and board reflect interest of shareholders.

How does the board review implementation for example? We need to pay more attention to that detail." ICRA's Duggal feels for things to really evolve, mindset has to alter.